A simple explanation of the world food price crisis

We’ve been hearing this week again about soaring food prices around the world. What’s going on? Here, we take a close look at key data on food prices and summarize the leading papers that have analyzed the problem.

A major rise in food prices occurred in 2008 and started again late last year (see the graph below):

In 2008, maize prices tripled, wheat prices increased 127 per cent, and rice prices increased 170 per cent. The Food and Agriculture Organization of the United Nations (FAO) estimates that at least 40 million people were pushed into hunger as a result. Over 1 billion people are already undernourished worldwide, and that number has been increasing by nearly 4 million people per year since the late 1990s. While a Millennium Development Goal is to reduce the number of undernourished by 50% between 1990 and 2015, this seems unlikely to be achieved. Those most affected by the price increases are low-income groups who depend on markets to access food; they spend up to four-fifths of their income on food, so even small increases in food prices have resulted in under-nutrition.

What’s causing the problem? There are a few short- and long-term causes that have been identified by leading food policy experts:

Short-term causes:

Loss of grain reserves: World cereal stocks (reserves) fell to just 405 million tons by the end of 2008–down 22 million tons from their already reduced level at the start of the season and their lowest level since 1982. According to the UN, “the private sector and international financial institutions maintained that holding public stocks is costly and inefficient”.

Less production: Compared to the period between 1970 and 1990, when the production of aggregate grains and oilseeds rose by an average of 2.2 per cent per year, the annual growth rate since 1990 has declined to about 1.3 percent. This has been attributed to lack of investment, climate change and water depletion.

Higher production costs: According to a World Bank analysis, the rise in oil prices during and after the Iraq War led to a rise in fertilizer and fuel prices, increasing production costs for farmers of corn, soybeans, and wheat by 21.7 per cent between 2002 and 2007.

Increased demand from India/China: The surge in food commodity prices has also been attributed to “strong per capita income growth in China, India, and other emerging economies” where a new middle- and upper-class “buoyed food demand, including for meats and related animal feeds, especially grains, soybeans, and edible oils”.

Speculation: Upon collapse of the housing market bubble in 2007, financial investors saw opportunities in the food commodities market given low global grain stocks that promised to increase prices and profits in the food sector. The greater demand created by investors’ speculation in commodity markets put upward price pressure on food and energy commodities, and hedge fund investors produced high volatility as these investors bought and sold large numbers of investments based on daily changes in market price to generate short-term profits. (See our prior explanation of how speculation works, or doesn’t work…)

Biofuels: There is new substantial demand for grains to be used as fuel. Political pressure to maintain subsidies for farming conglomerates in the US and EU have sparked this demand, resulting in the 2007 United States Energy Bill which nearly quintupled the biofuels target to 35 billion gallons by 2022, and the EU’s analogous laws to use biofuels for 10 per cent of its transportation by 2020. Without these increases, “global wheat and maize stocks would not have declined appreciably, oilseed prices would not have tripled, and price increases due to other factors, such as droughts, would have been more moderate.”

Long-term factors:

Less trade regulation: In the 1980s and 1990s, international financial institutions (the World Bank and IMF) strongly encouraged the elimination of agricultural marketing boards, in order to privatize agricultural sectors and remove regulators that managed the national stock of food supplies. Marketing boards had frequently been plagued by corruption, however they did have a role in preventing price volatility, protecting producers and consumers against sharp rises or drops in prices, and promoting self-sufficiency to reduce the need for food imports or foreign exchange earnings.

Less investment in agriculture: The World Bank’s 2008 World Development Report concluded that agricultural growth has been about four times more effective in raising the incomes of extremely poor people than growth outside the agricultural sector, yet investment in agriculture as a share of total public spending in developing countries fell by half between 1980 and 2004. This decline in investment is thought to have contributed to declining agricultural productivity in developing countries.

Less tariffs, more import surges: Agricultural conglomerates in the EU and US have profited from subsidies while flooding poor country markets with their excess products, to the detriment of farmers in the poor countries who can’t compete. In 2003, the United States exported wheat at 28 per cent below the cost of production, soybeans at 10 per cent below the cost of production, corn at 10 per cent below the cost of production, cotton at 47 per cent below the cost of production, and rice at 26 per cent below the cost of production. These import surges result in the closure of domestic farms in poor nations, later causing inadequate agricultural production after the import surges subsided.

Reliance on export crops: At least 43 developing countries depend on a single commodity (sugar, coffee, cotton or bananas) for more than 20% of their export revenue, because they were encouraged to do so via free trade agreements and international lenders who viewed this as a means of economic growth [see Oxfam’s critique of Ricardo’s theory of comparative advantage (p. 57-60 of the link), the basis of modern free trade theory]. As a result, these countries became exposed to the volatility of stock markets, which have produced sharp declines and rises in earnings, dependency on imports for daily foods, and insufficient domestic production of consumer crops when import prices surge.

What’s the impact of the food price surge on hunger?

It’s hard to know–at best, we have estimates from the FAO, which suggest at least 40 million new hungry people after the 2008 spike (it’s unclear how many more will be added by the current spike). Where did this number come from? The FAO uses a complex method to predict hunger. They first estimate the number of hungry people by combining data on production, imports and exports of all food commodities, along with the calorie content of each food (to calculate total available calories in a country); data on population structure in terms of age and gender (to estimate the total caloric requirements of the population); and household survey data to estimate the country-specific distribution of calories (incorporating within-country inequality in access). To determine how much this number of hungry people will change with the food price rise, they multiplied their overall estimate of hungry people by a USDA estimate of how much food access changes with rising prices; the USDA has an Economic Research Service model to estimate how changes in capital flows, exports and commodity prices would affect people’s ability to purchase food based on prior history. The USDA model’s disadvantage is that it excludes middle-income developing countries (like South Africa or Brazil) that have a lot of inequality and poverty, and uses a definition of under-nutrition as being anything <2100kcal per day (not accounting for subtleties like vitamin deficiencies, which can appear even when people get enough calories to survive).

So what should we do to prevent famine?

Governments have taken a number of measures: reducing import taxes on food, dispensing grain from national reserves, restricting exports to keep food domestically available (a controversial approach in light of trade agreements), and price controls/subsidies for consumers. But it’s not clear whether these have worked (research project, anyone?). The Oakland Institute has a very detailed assessment of what does seem to be important during food price spikes of the past:

[1] regulate the financial markets so that hedge funds’ right to swing the financial markets up and down for profit stops at the farmer’s nose (or plate…);

[2] reinvest in social safetynets like national food reserves that help absorb price shocks instead of assuming the market will help everyone;

[3] not only boost food production (which is the big topic of conversation right now, as The Economisthighlighted), but remember that Amartya Sen won a Nobel Prize in economics for showing us that famine happens not simply when there’s too little food to eat, but often when there’s enough food lying around but people can’t afford to buy it. Latest numbers from the UN show that there’s enough food in the world to feed the world’s hungry. (As a medical footnote, regular food is not always enough to recover from under-nutrition, as Doctors Without Borders has shown through their campaign to use fortified foods for the severely malnourished).

What about food aid? Well, for years, US and European farming conglomerates like ADM received billions of dollars in taxpayer funds to subsidize their excessive production of corn and other products, and the excess product was “dumped” in poor countries, often putting poor farmers out of business while claiming the extra grain was aid to prevent famine. Properly-distributed aid is, however, essential in poor communities to helping support local food systems (e.g., supporting local small-scale agriculture). But we should acknowledge that even when effective, today’s aid levels are not even one-third as large as the remittances sent by kin to their families (people working abroad and sending money home via Western Union), which totaled $340 billion in 2008 (a 40% rise since before the food price spike). So while aid is important, it’s not the big determinant of famine or fortune, and we don’t want to end up being like this aid worker (don’t we all remember her from our college seminars?):